Deposit insurance is an addiction, not a drug

NEW YORK, March 16 (Reuters Breakingviews) – Deposit insurance is as American as apple pie and twice as unhealthy. After Silicon Valley Bank and Signature Bank ( SBNY.O ) failed over the weekend, Uncle Sam stepped in, promising to bring back all its customers. The move may have prevented a wave of run on copycat banks. But the idea of ​​bailing out savers without limit is both impractical and futile.

Risk-free banking for most households is the norm almost everywhere, but it is a new invention. With the exception of the United States, which started the trend in 1933, most countries launched formal deposit guarantees only in the last 50 years. Britain joined the club in 1979, and Europe imposed coverage on member countries’ banks in 1994. China was a latecomer in 2015. New Zealand is one of the few countries, although a scheme is making its way through parliament.

The main appeal of deposit guarantees is that they reduce the risk of bank runs. The failure of SVB Financial ( SIVB.O ) highlighted the weakness of that thinking. Bank deposits in the United States are guaranteed up to $250,000, and over 90% of SVB accounts contain more than that amount. This is a widespread vulnerability. About $7 trillion of all U.S. deposits are uninsured, 40% of the total. 30 years ago it was under 20%.

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SVB customers were not wrong to flee when they sensed danger. When a bank fails, the Federal Deposit Insurance Corporation, which supports savers using funds raised from a tax on the banking industry, usually steps in and finds a buyer to take on depositors of all sizes. But not always. The Washington Federal Savings Bank that failed in 2017 left uninsured depositors stranded. Even today, only 42% of claims are paid, according to the FDIC.

Although the FDIC only promised to make SVB and Signature customers whole, the idea that it had set a template for the industry helped take the heat out of the crisis. The question is what happens next. At some point, the authorities will have to clarify their position. There are a total of three choices they can make.

One is to try to cast a larger and more durable safety net around savers. When the financial crisis hit in 2008, the FDIC heroically promised to back all deposits in non-interest-bearing accounts that had not yet been covered. He can’t do it this time. The Dodd-Frank Act of 2010 limited the FDIC to offering unlimited guarantees to depositors of an individual bank that must be in receivership. FDIC Chief Martin Grunberg could still team up with Treasury Secretary Janet Yellen and Federal Reserve Chairman Jay Powell to propose joint insurance if their agencies agree a crisis is underway, but they would need approval to Congress, which they almost certainly won’t get. They will also need to overhaul regulations to ensure that even smaller banks can fail without hurting depositors.

Alternatively, regulators could invite the market to provide a solution – say, with privately funded insurance for deposits above the guaranteed limit. Massachusetts already has this, although its banks are small. Germany also enjoys unlimited insurance provided by a club of private banks. If American lenders or their customers were willing to pay a fair price to make the deposits leak-proof, perhaps a consortium of financiers could step in. The FDIC discussed this possibility back in 2007, but concluded that a scheme of this type would likely need some type of government safeguard.

The problem is that deposit insurance is like novocaine – the higher the dose, the more numb the patient becomes. SVB’s wealthy clients have already turned a blind eye to the bank’s erratic funding and losses in its investment portfolio. If they knew their deposits were risk-free, they would be even lighter. Conversely, if SVB’s managers believed that their patrons could flee, they might have been more careful in accumulating long-dated securities that they could not easily sell.

For this reason, your best bet is probably to do nothing – or better yet, lower your deposit guarantee limit. This may seem cruel. Deposit guarantees, with their aura of protecting the small saver, have a folkloric appeal, reinforced by the cinematic lesson in banking that is Life is Wonderful. But most Americans have far less than $250,000 in the bank. At JPMorgan ( JPM.N ), the average insured deposit is just $7,000.

For tens of millions of customers, the $250,000 limit is a benefit they don’t need, but it still helps with financing. Lenders must pay a fee to the FDIC to cover future payouts, an amount that has risen this year because the fund has not had enough reserves. The fee is calculated not only on the insured deposits, but also on all his liabilities. As with any cost, bankers have an incentive to offset this through customer fees, which tend to fall hardest on low-income households. Therefore, reducing the cap should appeal to both small-government Republicans and progressive Democrats.

With savers and investors nervous, regulators will have to tread carefully. It is difficult to get uninsured depositors to understand the dangers they face. If SVB’s venture capital and tech startup clients don’t notice the risks, others are unlikely to be more vigilant. And if savers find themselves on the hook for losses at small banks, funds will fly to larger lenders such as JPMorgan and Bank of America ( BAC.N ) or migrate to non-banks such as money market funds. Over time, however, this is preferable to the false pretense that uninsured funds are safe come hell or high water.

Once the smoke clears, the healthiest thing to do would be to reduce the 90-year-old convention of risk-free banking to a minimum. After all, the American system is extraordinary in its generosity. Canada’s insurance limit is $73,000, one-third that of its neighbor, even though the two countries’ per capita bank balances are the same. The UK limit is $100,000, as is Switzerland. The FDIC used to cap insurance at the same level, but raised it during the financial crisis of 2008. By setting the bar too high, the architects of American finance made banking riskier and less fair.

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(The author is a columnist for Reuters Breakingviews. The opinions expressed are his own. Adjusts the level of uninsured deposits in the first chart.)

Editing by Peter Tal Larsen and Amanda Gomez

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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence and freedom from bias.

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